Funeral For a European Myth

Here we go again -- the death of another myth, namely the one that Europe's worrisome sovereign debt crisis has run its course. Far more likely, the evidence shows, we're in for a nasty rerun.

To put it in perspective, let's turn the clock back about six months when the U.S. stock market was repeatedly getting battered on a daily basis in response to news of swelling debt woes in Europe. Adding to the market's shellacking at the time were riots in Greece over proposed austerity measures.

Then came Superman to the rescue, the European Union, with a promise of a $1 trillion bailout package to stabilize Europe and drive away the bond vigilantes who were selling the debt of the weakest European countries, causing interest rates to rise. In response, the euro, aided by Chinese purchases, proceeded to strengthen, and fears of a debt crisis in Europe greatly diminished, so much so that many market pros have eliminated this risk from their radar screens.

Judging though from the recent downgrade of Ireland's credit by the Fitch rating agency, which came on the heels of earlier downgrades of Spain's and Portugal's debt, it's pretty clear that only Rip Van Winkle would dismiss the danger of a fresh outbreak of European debt problems, which has ominous implications for the world's financial markets.

That's also the thinking of currency tracker Bryan Rich, editor of the World Currency Alert newsletter in Jupiter, Fla., who says "a higher euro may have instilled some investor confidence, but nothing has changed. Not only does a debt problem exist," he says, "but it's getting progressively worse and a default by a European country is only a matter of time."

Addressing the trillion-dollar rescue package, Rich describes it as "nothing more than bold shock and awe, a promise that's a figment of someone's imagination." He notes that a number of the more financially muscular European countries, among them Germany, are already balking at the idea of anteing up funds to help bail out their weaker brethren.

London money manager Raymond Stahler of Stahler Dearborn, Ltd., concurs. He describes the $1 trillion promise of aid to the struggling European nations, such as Portugal, Ireland, Greece and Spain, as a farce. "Handouts are wonderful," he says, "but not if nobody is handing out."

Rich views the European financial situation as especially scary in Ireland, which he views as most vulnerable to a default. The European Union's guidelines prohibit its member nations from having their budget deficits, as a percentage of GDP, exceeding 3%.

That's a meaningless number, though, since no one is paying any heed to it. For example, the 2010 estimates call for Ireland to top the limit by more than 10-fold at 32%, followed by Spain at 9.3%, Portugal at 8.8%, Greece at 8.1%, and Italy at 5%.

The EU's limit on total debt, as a percentage of GDP, is 60%. Here again, Ireland strikes out badly. Its 2010 projection had called for 65%; it's now projected at 110%.

Against this background, a massive amount of debt in the European nations has to be rolled over. A dilemma here is that the governments and the banks will be competing for capital, which will drive interest rates higher. That, in turn, will make it difficult for the governments to raise money at rates they can afford, which, in turn, could cripple the ailing economies.

At the same time, Rich notes that the European Central Bank, which has been snapping up government debt of struggling countries to keep them solvent, has acquired a lot of crappy debt.

A related problem, as he sees it, is the threat of another major wave of risk aversion. That is when capital flees riskier investments and assets. The chief implications, as Rich sees them: Stocks will go lower, the same for commodities, except gold, and it all bodes well for the dollar.

What does all of this mean? Rich's view: "We're in a crisis period, a deleveraging phase for the world's economy, so look for more shocks, such as government defaults, bank failures, currency devaluations and rising protectionism."

He doesn't say it in so many words, but the word from Rich is clear: Watch out -- you could get poor!